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Usually, conservatives in the U.S. are in favor of "stable money," while
liberals favor more
active involvement by the central bank to reduce unemployment. But what is this "stable
money"? Conservatives are confused.
These themes go back over
120 years in the U.S. In the 1896 presidential election, Democratic candidate William Jennings
Bryan favored "free coinage
of silver," a rather
arcane term that meant people could take 50 cents of silver to the mint and get a $1 coin in
return. It amounted to a 50% devaluation
of the dollar. This was to allow
heavily indebted farmers to pay off their debts.
Republican candidate William McKinley favored
"sound money," which
meant remaining on the
gold standard without a devaluation.
McKinley won, and the dollar remained at its $20.67/oz. parity until 1933, when it was
devalued by Democrat
Franklin Roosevelt to $35/oz.
"Stable money," historically, has always meant a gold standard.
But perhaps many do not quite see the connection today between this abstract notion of
"stability" and gold.
"A currency, to be perfect, should be absolutely invariable in
value," said David Ricardo in
1817.
This seems simple enough,
but notice what he did not say: he did not say
that a currency should have an absolutely
invariable quantity ("money supply"), or invariable rate of quantity
growth, or that prices should be perfectly stable (invariable
"purchasing power"), or that the currency should reflect gold imports or current account balances or government fiscal balances. "Stable money" means money with a stable
value.
The idea behind any gold standard system is that gold is stable in
value--the most stable thing
that can be identified in this world--so if your currency's value is linked to gold it will be
as stable as can be achieved.
This principle was put into practice for over two
centuries in Britain. After
200 years, the British would
know if it worked or not,
right? They were the ones who had
to live with the consequences,
good or bad. Their conclusion
was that it was the best system humanly possible.
It may seem that "stable purchasing
power" is a desirable
goal, but this is not at all the same as stable
value. For example, if you
live in Manhattan, and then travel
to Puerto Rico, you might find that
the purchasing power of your
dollar bills increases by several
multiples. However, their
value remains the same.
This wild change in "purchasing
power" doesn't bother
anyone, because they understand instinctively that the value of
their money is stable. However, if the dollar falls against the euro, from $1.25
per euro to perhaps $1.75--a much
smaller percentage change
than the effect of
travelling from Manhattan to Puerto
Rico--much consternation results
as people fear that the
value of their currency is declining. During this move from $1.25 to $1.75 per euro, the actual
purchasing power of the dollar, in terms of the Consumer Price Index for example,
may hardly change at all.
If gold is stable in value, then
a decline in the dollar's
value vs. gold--the "exchange rate with
gold"--reflects a decline
in the real value of the dollar. John Stuart Mill, writing
in 1848, explains:
"[T]here is a clear and unequivocal
indication by which to judge
whether the currency is depreciated, and to what extent. That indication is, the price of the precious metals."
This decline in the market
exchange rate between gold and the floating currency is eventually reflected in the market
exchange rate between all other
goods and services and that
currency, an adjustment process known informally as "inflation." This adjustment process can take many
years, even several decades.
In this same passage,
Mill also describes how
to peg a paper currency to gold, even if the paper currency is not "convertible."
"If, therefore, the issue of inconvertible paper were subjected
to strict rules, one rule
being that whenever bullion rose above the Mint price [gold parity], the issues
should he contracted until the market price of bullion and the Mint price were again
in accordance, such a currency
would not be subject to any of the evils usually deemed inherent in an
inconvertible paper."
This is the "currency
board linked to
gold" supply-adjustment mechanism
I often write about.
Today, conservatives are not quite
sure what they mean by "stable money." They
have a murky notion that
the Keynesian system favored
by Democrats--"easy
money" to counteract unemployment--is perhaps not such a good idea, but without a clear alternative,
conservatives tend toward some
variety of "less easy money" within the Keynesian floating currency framework.
Widespread understanding
of gold standard systems was
lost, and must now be relearned. A variety of cloudy notions regarding money supply, "purchasing power," CPI-targeting,
currency baskets and the like
have migrated to fill the
vacuum. None of these systems
will produce money that is stable in value.
I invite anyone to try to
invent a system that will work
better than a gold
standard at achieving the
goal of stable currency value. You will find that
it is exceedingly
difficult, even at the theoretical level. No such system exists today, not even as a proposal, and certainly no system with
centuries of proven real-world success.
Nathan Lewis
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